One year of demonetisation: We are playing for the future not the past

The government’s move to demonetise high-value currency, announced on November 8, 2016, was meant to root out unaccounted wealth, stem terror financing and curb counterfeiting. It has been argued that the move did more harm to the economy than good. But was the note ban move solely responsible for the economic slowdown seen in the subsequent months? A year after demonetisation, Rahul Jain finds out the demonetisation effects in this piece for Business Standard.

The year 2016-17 will be remembered in India’s history for major structural reforms. In November 2016, the Government decided to ban high-value currency notes of Rs 500 and 1,000 denominations. Eight months later, Goods and Services Tax (GST), the unified and simplified indirect tax regime, was implemented nationally. Nearly a year since demonetisation and the subsequent implementation of GST, the dent on the economy has been substantial.

According to the International Monetary Fund (IMF) estimates, growth will climb back to 8% over the medium term, once again restoring India as the fastest-growing economy globally. 

Economic indicators signal a strong recovery

The data that have flowed over the past few weeks signal towards a revival in growth. High-frequency indicators for consumption, such as two-wheelers and passenger vehicle sales (+14%), fuel consumption (+10%), festive sales for e-commerce portals (+15%), and other macro indicators like exports growth (+25%) and industrial production (+4.6%) paint an optimistic picture. If one looks at the past two quarters in totality, the averages signal a steady pace of recovery adjusted for the short-term impact of the reforms.

Shot in the arm to the banking system 

Inflation in September remained unchanged at 3.28%, with food inflation pulling the inflation down. However, the probability of another rate cut seems weak. Of the total capital infusion, Rs 1.35 lakh crore is supposed to come via recapitalisation bonds and Rs 76,000 crore via market loans and budgetary support. Total stressed assets of state-run banks would amount to around Rs 8 lakh crore. Of this, provisioning has been down to the tune of Rs 4.55 lakh crore. Taking a 50% haircut, government banks’ un-provisioned stress would amount to around Rs 1.72 lakh crore. Thus, the amount announced seems adequate. 

In this scenario, the focus would rather be on the transmission of lower interest rates rather than further cuts. Banks have thus far been reluctant to pare lending rates on account of stressed assets. Much to the discontent of the Reserve Bank of India (RBI), banks have not kept pace with the transmission of rate cuts passed on to borrowers. The marginal cost of funds-based lending rate (MCLR), which came into effect in April 2016 for effective implementation of rate cuts, has only been lowered by 0.23% over the past year. 

Exports surging, trade and current account deficits under control

Exports surged to a nine-month high, rising 26 per cent (y-o-y) in September. On a 3-month moving average basis (3MMA), exports grew by 13% (y-o-y). Global Tailwinds like improving global PMI along with smoothening of GST-led disruptions aided recovery in exports. Engineering goods continue to drive export growth. Imports have also slowed down, mainly due to lower gold imports. Gold imports declined by 5 per cent in September, against a rise of 68 per cent in the previous month. 

Attacking the GST loophole by imposing a ban on gold imports from countries like South Korea and Sri Lanka seems to have borne fruit. The trade deficit narrowed to $9 billion in September from $11.7 billion in August. Going ahead, we expect trade and current account deficits to both remain in check for FY18. We estimate current account deficit to be around 1.5% of GDP for FY18.

Ambitious projects announced 

The government announced the biggest road construction programme in India’s history to create 84,000 km of roads over the next five years, with a total investment of Rs 6, 92,000 crore. After the National Highway Development Programme (NHDP) planned during the previous NDA government, this is the biggest road construction activity planned in India with a clear road map for execution and financing. 

Importantly, a clear road map has also been given out for financing the the overall capital requirement. Of the Rs 6.92 lakh crore, Rs 2.09 lakh crore would be market borrowings, Rs 1.06 lakh crore is expected to come from private participation, Rs 2.19 lakh crore will be funded through the Central Road Fund, Rs 59,000 crore will be budgetary support and rs 34,000 is expected to come from monetisation of existing road assets under the toll-operate-transfer (ToT) model.

Globally, industrial activity and economic growth have continued to rise at a robust pace. Geo-political risks, though, continue to remain elevated. They are high-intensity but less probable events. However, such events cannot be predicted.

Market and earnings outlook 

Indian equity markets seem heading towards a stellar quarterly performance in Q2 FY18, mainly driven by restocking after GST-led disruption and low base for state-run banks. At the onset of the result season, we had estimated a 13% rise in earnings growth for the Nifty. Going by the results that have been released so far, our estimates look realistic. The Indian macro scenario looks stronger than ever, with low inflation, buoyant exports and fiscal stimulus. Loose monetary and fiscal policy augur well with economic growth.

We continue to remain bullish on the Nifty, as there are long-term growth levers. Road construction, financials, consumption and commodities continue to be our top sectors. As earnings growth pick up in the remaining quarters, the target of 11,100 by March 2018 seems achievable. With an earnings-per-share growth estimate of Rs 515 for FY18, the Nifty currently is trading at 19x. Looking at forward guidance and expected growth trajectory, it looks like the rally will continue.

Conclusion 

Demonetisation and GST did have an impact, to an extent. However, economists and markets had already expected a slowdown. So, as investors we should be aware about what we are playing. We are playing for the future not the past.

The author is head of retail advisory, Edelweiss Wealth Management